ExplainSpeaking: How to Evaluate a Union Budget (2023)

Dear readers,

This will be a crucial week for the Indian economy.

For starters, even before the Union Budget is unveiled on Wednesday, the immediate future of India's equity markets and the well-being of retail investors is likely to be determined by how theshares of the Adani group of companiesrun on Mondays and Tuesdays. Already in 2023, even without the complaints andHindenburg's Research Results, Indian stock markets were one of the worst performers in the world. In particular, foreign investors have been pulling money out of India. The Adani Group, which has already lost billions of dollars in market value in a matter of days,issued a detailed rebuttalbut it all depends on how investors see it.

Then, on January 31, two important documents will be released.

um, it's theeconomic research, prepared by the Chief Economic Advisor. Two, Tuesday will also see the release of the latest World Economic Outlook update from the International Monetary Fund. Both documents will include indicators on the prospects for the Indian economy.

On February 1, the US central bank will also publish its next policy decision. The United StatesFederal ReserveThe decision of is likely to have an influence on Indian markets as well as the RBI's own monetary policy stance, which will be revised in late February.

But perhaps the most far-reaching impact is that ofunion budget. As explained in one of the previous editions of ExplainSpeaking, 2023 is expected to be a particularly challenging year from an economic growth perspective, as the underlying effects will wear off and India's true economic momentum is likely to be revealed. The prospect of subdued global growth, if notrecession, makes the year even more difficult. A sustained high interest rate regime in the US will put pressure on Indian policymakers to keep interest rates high at a time when they may want to be more concerned about growth as the domestic marketinflationtrend is starting to relax a bit.

Finally, geopolitical uncertainty continues. He not only has theUkraineThe conflict has not been resolved, but there are early signs of rising tensions between the US and China. Reuters quoted a top Republican in the US Congress as saying the likelihood of conflict with ChinaTaiwan"they are very tall".

The importance of all these factors is further heightened by the fact that India is entering an intense political season with several state elections in 2023 and national general elections in early 2024.

While several of these factors, like what happens in the rest of the world economy, the US.fed, geopolitical uncertainty and how stock markets react may be beyond the government's control, the Union budget can play an important role in stabilizing the ship.

But how to evaluate or judge a Union Budget?

It is true that Union Budgets tend to differ from year to year. However, here are five metrics that any union budget should meet.

1: The budget talk: often more is less

Abraham Lincoln once apologized for writing a letter that was too long. But the reason he gave for doing this was very instructive.

“I'm sorry for writing such a long letter. Didn't have time to write a short," Lincoln wrote.

Another legendary US president, Franklin Delano Roosevelt (or FDR) advised: "Be honest, be brief, sit down."

The speech presents the Budget to the public. Stripped of all the talk around it, the Budget is essentially an annual financial statement. What the public needs to know is whether it will pay more or less taxes, will the government be able to pay its bills (and if not, how much will it borrow from the market), and finally, where will the government be? spend all your money.

Minister of FinanceNirmala Sitharamanalready delivered theLongest budget speech in Indian history. But more often than not, a long speech suggests too many tweaks or a lack of clear focus.

For example, in his first speech in 2014, then FM, lateArun Jaitley, announced around 27 new schemes with an allocation of Rs 100 crore each. These schemes ranged from modernizing madrasahs to a program promoting "good governance" and a national mission on the Pilgrimage for Spiritual Rejuvenation and Upliftment (PRASAD) to transforming existing job boards into career centers. , etc.

Although Rs 100 crore might seem like a big enough amount for an ordinary person, in the general scheme of things (Union budget that year was almost Rs 18 lakh crore), this is a minor amount and the change to start so many schemes with such a meager allocation is more about scoring political points or mitigating criticism than achieving a clear political goal.

Likewise, one can recall railway ministers of yesteryear meticulously announcing the name of every new train they operated on the eve of a general election.

2: The budget numbers: credibility is key

As explained in last week's article, the entire budget is based on certain assumptions of economic growth and revenue growth. But sometimes government assumptions baffle everyone.

For example, in the full budget for 2019-20, the first budget of Prime Minister Modi's second government, FM Sitharaman assumed a nominal GDP growth of 12%. Assuming inflation is 4%, which is the RBI's mandate, this suggests that the FM expects real GDP to grow by 8% in 2019-20.

"GDP for BE 2019-2020 is projected at Rs 21100607 crore assuming 12.0% growth on the estimated GDP of Rs 18840731 crore for 2018-2019 (RE)," the Budget at a Glance document stated. BE refers to Budget Estimate and RE refers to Revised Estimate.

There was only one problem. This budget was presented in July and by then it was clear to all observers that the Indian economy was slowing down sharply. In fact, early on the government's own data revealed that the economy grew only 5% in the first quarter of that fiscal year (April to June). Furthermore, the economy has been facing a secular slowdown since the beginning of 2017-18.

It turns out that the economy only grew 3.7% that fiscal year, less than half what the FM had forecast in a quarter of the fiscal year.

This meant that all other budget calculations were wrong. But, equally important, it undermined the credibility of the Budget numbers, as everyone outside the government doubted the assumption that the economy would grow by 8%.

3: The revenue deficit is as important as the fiscal deficit

The fiscal deficit (that is, the amount of money the government borrows from the markets) is often the most talked about metric in any federal budget. This is for two reasons.

First, India has legislation, the Fiscal Responsibility and Budget Management Act (FRBM), which stipulates the maximum level of fiscal deficit allowed to any government, union or state.

Two, if a government exceeds its fiscal deficit, it risks the wrath of markets. A good recent example is what happened in the UK under the leadership of Prime Minister Liz Truss and her Chancellor Kwasi Kwarteng. They introduced a “mini budget” which, in an attempt to boost growth, resulted in the creation of a huge fiscal gap. They expected the markets to trust their growth plan and force them to lend them the money. Instead, the markets rejected them, leading to a financial crisis that cost them both their jobs.

In the case of India, however, it is not just the fiscal deficit that needs to be considered. It is equally important to note the revenue shortfall.

Simply put, the revenue deficit is the difference between daily government expenditures (eg wages and pensions) and daily profits (taxes, taxes, etc.).

The original mandate of the FRBM Act was twofold: a revenue deficit of 0% (of GDP) and a fiscal deficit of 3% (of GDP).

In other words, fiscal prudence requires the government to cover its daily expenses out of its daily income, while borrowing (fiscal deficit) only for capital expenditures (i.e. expenditures for the production of productive assets such as roads and bridges).

The important point to understand here is that when the government spends Rs 100 on capital expenditure, the returns to the economy are close to Rs 250, while when it spends Rs 100 on revenue, the returns to the economy are only 100 rupees.

In other words, by forcing the government to borrow only for capital expenditures, the original FRBM Act helped fuel economic growth.

However, in 2018, the government gave up the condition of revenue deficit and started to focus only on the fiscal deficit. In the absence of this condition, one can imagine a scenario where the fiscal deficit is 3% (of GDP), but all this money is borrowed to cover day-to-day government spending because even the revenue deficit is 3% (of GDP). GDP).

THE GRAPHIC below, taken from last year's Budget, shows how the downward trend in revenues has worsened since then.

Deficit trends from 2008-09 to BE 2022-23.

When the latest budget is presented, the fiscal deficit figure should be read along with the revenue deficit data to understand how much money the government intends to borrow in the next fiscal year will be used to pay daily bills and how much of it. will be used to increase the productive capacity of the economy.

4: Income Goals: Are They Realistic and Fair?

There are two aspects here.

One of them is the calculation of divestment targets. A cursory look at past targets over the decades suggests that divestment targets fluctuate wildly from year to year. Often their accomplishments also fluctuate wildly.

A particular problem is that often the divestment target is calculated at the end of government revenue calculations, that is, after revenue assumptions from all other sources have been made. Thus, there is a strong temptation to stretch the divestment target based on the gap that needs to be filled.

This practice often leads to unrealistic divestment targets. This, in turn, undermines the credibility of the Budget numbers. This is because if the divestment target is not met in a given year, it immediately means that the fiscal deficit will increase over the budgeted level.

Second, when it comes to taxes, there is the issue of fairness. Ideally, India should have a tax regime where taxes increase as you go from poor to rich. Thus, direct tax rates, whether IRS or IRC, should increase as the richest entities are considered. Likewise, indirect taxes (read GST) should be low because they affect the general population in the same proportion and, logically, the poor bear the brunt of higher GST rates.

Obviously, the GST is outside the scope of the Union's budget. But ideally, the government should work towards a tax system with low indirect taxes and progressively higher direct taxes.

Given high inflation in recent years, it's tempting to argue that the wage-earning class should get an exemption or some relief, and perhaps it should, but remember that the best relief will come in the form of lower excise taxes. It is by lowering the GST that India's depressed levels of consumption will improve. Higher demand will also create more economic activity and jobs.

5: Spending: What are India's top priorities?

In spending allocation, the trick is to find out what the country's priorities are. Pakistan offers a clear example of a nation that prioritized its military power over the health and education of its people.

In India, for every 100 rupees spent by the government, only 2 rupees goes to public health. Also on education, the government spends Rs 2.

Spend 10 rupees on defense. Rs 12 is spent on subsidies (food, fuel and fertilizer). And 22 rupees are spent to pay interest on past loans.

Health spending is staggering when you consider that India not only has the largest group of poor people in the world, but also the largest group of malnourished children in the world.

The same applies to the budget allocation for education. Despite rising school enrollments, India's learning outcomes are poor.

No country rose to world domination without first investing substantially in the health and education of its people.

All hopes of India becoming a superpower depend on India harnessing its human resources. But while much is made of the promise of India as the world's back office, little thought is given to the threat of automation.

There are no easy answers here.

For example, what would happen if fuel and fertilizer subsidies were removed and the money went to health and education? The prices of various items such as grain and energy prices will rise. It can be argued that this must be done. A portion of the resulting savings can be donated directly to people who are too poor to buy food. The trade-off is that this would hit poor and marginalized farmers hardest, as well as poorer energy consumers. Instead, cuts must be made in other sectors, such as defense and pensions.

Likewise, a key factor in choosing allocation should be whether the money spent maximizes job creation. India has been suffering from massive open unemployment and several experts argue that rather than granting tax breaks to large companies, the government should support India's micro and small businesses and urgently invest in upgrading their skillset.

What should the government do on February 1st? What are your expectations for the Union's budget for 2023? Share your thoughts and queries at udit.misra@expressindia.com

See you next week,

handsome man